Living on the Fault Line
Chapter OneUnderstanding Shareholder Value
What is a share of your stock worth? By definition a share entitles its owner to a percentage of the future returns of your business. Owning all the stock in your company would entitle one to 100 percent of all your future earnings forever. What, exactly, should that be worth? And how would or could one know?
The challenge lies in the word future -- how to value what is essentially a bird in the bush, not a bird in the hand. Investors and analysts must find some way to understand your business and its future trajectory so that, at any given price, they can decide whether to buy, sell, or hold your stock.
This has led to something of a consensus around the following as the fundamental valuation formula:
The total value of a company, its market capitalization, is equal to the present value of its forecastable future earnings from current and planned operations, discounted for risk.
Let's parse this sentence one phrase at a time. We're interested in the present value because the initial competition for all investment is cash-investors keeping their cash in hand and not parting with it to anyone. How much of ... read full excerpt from Living on the Fault Line, Revised Edition: ebook
